Chapter 3
Insurance Company Operations
1. (a) Ratemaking refers to the pricing of insurance and the calculation of insurance premiums.
(b) The insurance company does not know in advance the actual costs of the insurance. Only after the period of protection has expired that an insurer can determine its actual losses and expenses.
When other products are sold, the company generally knows in advance the costs of producing those products, so that prices can be established to cover all costs and yield a profit
(c) Actuary studies important statistical data and determine the level of insurance premium which is profitable yet sustainable to ensure company compete effectively in the market
2. (a) Underwriting is the process of selecting and classifying applicants for insurance. (b) There are several important underwriting principles:
(1) Attaining an underwriting project
(2) Selecting insureds according to the company’s underwriting standards (3) Providing equity among policyholders
(c) In determining whether to accept or reject an applicant for insurance, underwriters have several sources of information. They include the application, agent’s report, inspection report, physical inspection, physical examination, attending physician’s report, and a Medical Information Bureau (MIB ) report.
3. Production refers to the sales and marketing activities of insurers. Agents who sell insurance are frequently referred to as producers. The key to the insurer’s financial success is an effective sales force. Marketing activities include the development of a marketing philosophy and strategy, identification of short- and long-run production goals, marketing research, developing new products, and advertising the insurer’s products.
4. From the insurer’s viewpoint, there are several basic objectives in settling claims: (a) Verification of a covered loss
(b) Fair and prompt payment of claims (c) Personal assistance to the insured
5. Several steps are involved in settling a claim:
(a) Notice of loss must be given to the company.
(b) The claim is investigated by the company. (c) A proof of loss may be required.
(d) A decision is made concerning payment.
6. (a) An agent typically has the authority to settle small first-party claims up to some maximum limit. This type of claim settlement is speedy, reduces adjustment expenses, and preserves the policyholder’s good will.
(b) A company adjustor is usually a salaried employee who represents only one company. After notice of the loss is received, the company adjustor will investigate the claim, determine the amount of loss, and arrange for payment.
(c) An independent adjustor is a firm or individual that adjusts claims and is compensated by a fee. An independent adjuster may be used when a catastrophic loss occurs. An insurer may also use an independent adjustor in certain geographical areas where the volume of claims is too low to justify a branch office with a staff of full- time employees.
(d) A public adjustor represents the insured rather than the insurance company and is paid a fee based on the amount of the settlement. A public adjustor may be employed by the insured in a complex loss situation and in those cases where the insured and insurer cannot resolve a claim dispute.
7. (a) Reinsurance is an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer (called the reinsurer) part or all of the potential losses associated with such insurance.
(b) Reinsurance is used for several reasons:
(1) To increase the company’s underwriting capacity (2) To stabilize profits
(3) To reduce the unearned premium reserve
(4) To provide protection against a catastrophic loss
(c) Securitization of risk means that an insurable risk is transferred to the capital markets through the creation of a financial instrument, such as a catastrophe bond, futures contract, options contract, or other financial instrument. These financial instruments are used as alternatives to traditional reinsurance.
8. Facultative reinsurance is an optional, case-by-case method used when the ceding company receives an insurance application that exceeds its retention limit. Reinsurance is not automatic. The primary insurer negotiates a separate contract with a reinsurer for each loss exposure for which reinsurance is desired. However, the primary insurer is under no obligation to cede insurance and the reinsurer is under no obligation to accept the insurance. If a willing reinsurer is found, the primary insurer and reinsurer can then enter into a valid contract.
9. (a) Under a quota-share treaty, the ceding insurer and reinsurer agree to share premiums and losses based on some agreed-on percentages. The ceding insurer’s retention limit is stated as a percentage rather than as a dollar amount. Premiums are also shared based on the same agreed-on percentages. However, the reinsurer pays a
ceding commission to the primary insurer to help compensate for the expenses incurred in writing the business.
(b) Under a surplus-share treaty, the reinsurer agrees to accept insurance in excess of the primary insurer’s retention limit, up to some maximum amount. The primary insurer and reinsurer then share premiums and losses based on the fraction of total insurance retained by each party.
Premiums are also shared based on the fraction of total insurance retained by each party.
However, the reinsurer pays a ceding commission to the primary insurer to help compensate for the acquisition expenses incurred in acquiring the business.
(c) An excess-of-loss treaty is designed largely for a catastrophe loss. Losses in excess of the primary company’s retention limit are paid by the reinsurer up to some maximum limit.
(d) A reinsurance pool is an organization of insurers that underwrites insurance on a joint basis.
Pools are formed because a single insurer alone may not have the financial capacity to write large amounts of insurance; the insurers as a group, however, can combine their financial resources to obtain the necessary capacity. Each pool member agrees to pay a certain percentage of every loss.
Another arrangement is similar to the excess-of-loss reinsurance treaty. Pool members are responsible for their own losses below a certain amount. Losses exceeding that amount are shared by all pool members.
10. (a) Information systems have changed the insurance industry by speeding up the processing of information and by eliminating many routine tasks. Computers are used in accounting, policy processing, premium notices, information retrieval, telecommunications, simulation studies, market analysis, forecasting sales, and training and education. Information can be obtained quickly with respect to premium volume, claims, loss ratios, investments, and underwriting results.
(b) The accounting department is responsible for the financial accounting operations of an insurer. Accountants prepare financial statements, develop budgets, analyze the company’s financial operations, and keep track of the millions of dollars that flow into and out of a typical company each year. Accountants also prepare state and federal income tax returns and file an annual convention statement for review by state regulatory officials.
(c) In property and casualty insurance, the legal department is often part of the claims department. The attorneys may serve as defense counsel for the company if claims are litigated. In life insurance, attorneys are widely used in advanced underwriting and estate planning. Attorneys also review insurance contracts before they are marketed to the public, provide testimony at rate hearings, and provide general legal advice concerning taxation, marketing, investments, and insurance laws. Finally, attorneys lobby for legislation favorable to the insurance industry.
(d) The loss control department is responsible for helping individuals and firms reduce the frequency and severity of losses. Loss-control services include advice on alarm systems, automatic sprinklers, fire prevention, occupational safety and health, reduction of occupational exposures, prevention of boiler explosions, and other loss- prevention activities. Also, the loss control department can provide valuable advice on the construction of a new building or plant to make it safer and more resistant to damage.